Department of Energy and Climate Change: Offshore electricity transmission-a new model for infrastructure - Public Accounts Committee Contents

2  Developing the market and the terms of the deal

6.  The early evidence of the first four licence competitions suggests that the Authority succeeded in developing the new market in a way which was well received by bidders.[7] However, the Authority appears to have achieved this by offering extremely generous terms to investors which appear out of line with the risks the investors were asked to bear.[8] The licences awarded to date did not include any construction risk yet they provide licensees with a guaranteed income linked to the RPI (Retail Price Index) for 20 years regardless of the extent to which the assets are used, and licensees only face limited penalties if their transmission assets are not available. Furthermore, investors are not required to share any gains made from debt refinancing or from excessive equity profits.[9]

7.  The Department and the Authority argue that bidders were in a price competition to secure these terms.[10] We have not, however, seen evidence that the generous terms that were offered secured lower prices for consumers than other less generous terms might have. In response to our concerns the Authority acknowledged the need to learn lessons from the initial transactions and to consider refinements to the terms of the deal for future licence awards.[11]

8.  The licensees and their investors benefit from a revenue stream guaranteed for 20 years provided that the licensees meet the performance requirements for electricity transmission set out in the licence. The first four licences guarantee payments totalling £566 million over the life of the licences.[12] It is unusual for a regulator to allow such a long period of guaranteed revenue without periodic reviews. The long fixed revenue stream means consumers could be left paying for assets which become redundant before the end of the 20 year period, and it also may restrict emerging opportunities to enter into deals with North Sea countries to develop an offshore grid. The Authority chose a 20 year licence to match the expected life of the undersea cable, but accepted it was a challenge to assess the likely life of assets far out at sea and told us it would reconsider the licence period in future awards. [13]

9.  The Authority's licence terms allow licensees to have all of their annual revenue increased annually in line with the RPI inflation measure over the 20 year licence period. This decision was taken despite the fact that around 80% of the licensees' costs are financing costs which can be fixed at the outset to avoid inflation risk.[14] Consumers will have to fund the resulting costs through increases in electricity prices. The Authority defended the arrangement on the grounds that they were seeking to attract finance from high quality pension funds which seek revenue streams rising with inflation to match their liabilities. Two pension funds are now providers of finance to bidders for current licences. However, the four initial licences were all financed without direct pension fund investment.[15]

10.  The financial penalties which the licensees can suffer for failing to make the transmission assets available for use are limited to 10% of their revenue in any one year, or 50% of one year's revenue deducted over a five year period.[16] Transmission Capital Partners, which was awarded four of the first six licences, told us that these levels of deductions acted as an incentive to maintain availability as incurring such penalties would quickly reduce the investors' returns.[17] The Authority also requires a bond from the licensees to protect the consumer from unexpected dilapidation or non-performance in the later years of the 20 year licences and could, in extreme situations of underperformance, withdraw the licence. As the licence periods progress we would expect the Authority to monitor carefully whether what appear to us to be limited penalties for poor performance are protecting the availability of the transmission supply in the way that the Authority expects. [18]

11.  Our predecessors on this Committee identified that investors in PFI contracts often took opportunities to make large gains from the refinancing of PFI bank loans as the market matured and the initial risks of projects had reduced.[19] In response to these concerns the Treasury introduced arrangements for refinancing gains to be shared with the taxpayer. Despite this clear lesson from the PFI market the Authority did not include any requirement for refinancing gains to be shared in its licence terms.[20] There appears to have been no liaison between the Treasury and the Authority to ensure that the lesson to share refinancing gains was passed on to the Authority. The Treasury told us that in this case the aim had been to get this new type of commercial arrangement up and running without restrictions or limitations. This is the same Treasury argument which allowed early PFI investors to receive large refinancing gains before gain sharing was introduced following pressure from this Committee. There is no evidence that the Authority has achieved much better pricing by omitting a gain sharing arrangement because the impact of seeking such an arrangement was not tested with bidders.[21]

12.  A further lesson from the PFI market, on which this Committee has reported, is that initial investors often take opportunities to sell their equity shares to realise early profits. In some cases this may indicate inefficiencies in the way that the equity shares were priced. For the PFI market this Committee recommended that standard contractual arrangements should be introduced to enable the public sector to share in investor returns above defined levels. [22] As with refinancing, the lessons from the PFI market do not appear to have been transferred to the Authority's licence arrangements. There has already been an early share sale on one of the four initial licences.[23]

7   C&AG's report para 3.3, Q81  Back

8   Qq 18,24,36,78-9,100,123 Back

9   Qq 18, 33-38 Back

10   Q 175 Back

11   Q 107 Back

12   Q 22 Back

13   Qq 88,156-7,160 Back

14   C&AG's report para 2.13 Back

15   C&AG's report, Figure 4, page 24; Qq 99-100, 175 Back

16   C&AG's report, Figure 3, page 21; Q 43 Back

17   Q 43 Back

18   Qq 93-94 Back

19   Committee of Public Accounts, The refinancing of the Norfolk and Norwich PFI Hospital, Session 2005-06, HC 694; The Refinancing of the Fazakerley PFI Prison Contract, Session 2000-01, HC 372 Back

20   C&AG's report, Figure3, page 21; Qq 148-151 Back

21   Qq 150-151 Back

22   Q 12; Committee of Public Accounts, Equity Investment in Privately Financed Projects, Session 2010-12, HC 1846, recommendation 8. Back

23   C&AG's Report para 3.13 Back

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Prepared 14 January 2013